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American Auto Industry - Driven to Fudge the Numbers

Companies / US Auto's Mar 26, 2007 - 08:21 PM GMT

By: Rob_Kirby

Companies

Much has been written lately regarding the woes of the North American Auto Industry and why they seemingly cannot compete.

Reasons proffered as to why the North American auto industry has fallen upon such hard times run the gamut from quality issues to aging work forces to greedy unions.

One of the less talked about or ignored issues that has greatly impacted the plight of the auto industry is the misreporting of inflation - thanks to financial shenanigans by Central Bankers like the Federal Reserve.


How Does This Impact Car Companies?

The misreporting of inflation statistics has materially impacted the prospects of the Auto Companies – but it goes further than that. The reality is that all mature companies with aging work forces and ESPECIALLY non-defense industry related companies with Defined Benefit Pension Plans are at risk.

Consider This:

Framers of these pension plans – who carefully set them up many years ago – knew very well, and planned accordingly for, the changing demographics of their work forces. They knew that folks would age and retire. They used sound planning to ensure that the proper amount of assets would be set aside to look after those whose labor was responsible for the company's growth.

But here's what happened:

Governments became more indebted due to the willingness of Central Bankers to loan endless amounts of money to them [in a fiat money system ALL money is loaned into existence]. Government's couldn't pay their bills, or, perhaps better stated, couldn't service their debt.

Central Bankers then helped their partners in crime by MISREPORTING inflation figures so as to lower government's cash cost obligations [virtually ALL government spending programs are indexed to inflation].

Experts who currently ‘reconstruct' inflation data – to resemble the same methodology as that used even 15 years ago - have concluded that real inflation is under reported [conservatively] by 500 basis points per year. John Williams of Shadow Government Statistics is one such expert. He has done brilliant work in this area of economics research.

The Effect of Understating Inflation By 500 Basis Points

First, one should understand and appreciate that market rates of interest [rates at which the government borrows money] are typically set 200 – 300 basis points above the inflation rate. Current government bond rates are approximately 4% - predicated, of course, by government reporting of ‘official' inflation rates of 1.8 – 2.2%.

Williams' work shows that the REAL inflation rate is more like 7 – 10%. The implications of this are as follows:

Government bonds and fixed income products are [and have been for quite some time] paying rates of interest which are roughly 5% lower than they should be.

General Motors, for example, has pension assets under management of roughly 120 billion. Their asset mix has always had a heavy weighting in bonds or fixed income equivalents. While the exact weighting [asset allocation] may vary over time, last week GM announced that their pension assets have shifted to an overweight position in fixed income;

GM shifts 20% of pension assets to bonds

General Motors Corp., Detroit, has moved 20% of its $119 billion in U.S. pension assets to fixed income from equities. GM officials wanted to “significantly lower volatility of asset returns and plan funded status,” said Randy Arickx, spokesman. The new asset allocation is 52% global bonds, 29% global equity, 11% alternatives and 8% real estate. The company's expected long-term annual return on U.S. pension plans has been lowered to 8.5% from 9% as of Jan.1. Further details will be released in GM's annual report, to be issued Thursday.

This means, by extension, that GM's pension assets have more than 60 billion invested in bonds.

Now, consider that a 5% haircut on 60 billion worth of fixed income investments amounts to 3 BILLION annually.

This implies that General Motors has been carrying around a multi-BILLION DOLLAR BALL AND CHAIN [every year – compounded] for the past 15 or so years.

Killing Them Softly

Pension managers today would be well advised to read some of John William's [Shadow Government Statistics] research. By ‘overweighting' the fixed income portion of their portfolios they are actually GUARANTEEING they fall behind. The ‘perceived safety' of bonds to their pension plans IS ACTUALLY as detrimental as slow moving flesh-eating-disease to its human body. Left unchecked, undiagnosed and untreated – it kills the host.

To get a fuller appreciation of just how toxic these sub-par returns have been on pension plans – we only need to take a look at this [admittedly somewhat dated] 2004 piece regarding Ford . The date of the article is not the important thing to take away from this – the CAUSE of the problem – which is CLEARLY identified – and the fact that this has been making a material impact for quite some time - IS:

According to Banc of America Securities' research note published yesterday, the returns from the company's pension fund have been lower-than-anticipated so far this year. The company is expected to have witnessed 2% returns on its pension assets, as compared to the expected level of 8.75%, the analyst elaborates. The consequent increase in the company's 2005 pension expenses is expected to restrict Ford Motor's growth prospects, the analyst adds.Ford Motors has $54 billion in pension assets, of which 70% has been invested in stocks, according to Banc of America Securities . [RK emphasis]

Framers of these Pension Plans NEVER envisioned or assumed that more than 50% of their plan's capital assets would be receiving five hundred basis points less than ‘historic' market rates of interest [real rate of inflation plus 2 – 3%].

Now, if you doubt my claims – consider the following:

This problem has NOT just affected the Auto Companies. All large companies [Airlines in particular come to mind] with Defined Benefit Pension Plans have been hammered in the same fashion. Many companies have even shifted away from Defined Plans.

It should also be noted that the corollary to the misreporting [understating] of inflation has been an ‘un-naturally' strong dollar which has CRUSHED the prospects of American exports – witness the growing record – structural - American Balance of Trade Deficit .

The Proof In the Pudding

The only large companies that have ‘escaped' this stealth attack are those of the military industrial complex where national security is concerned . As Robert Bell reports;

Federal government contractors operate under a special law, CAS, in their defined benefits pension plans. This gives them stock portfolio insurance, something which small fry players would obviously like to get, but can't find anyone willing to issue. Should the pension funds of the federal government contractors lose money in their investments to the degree that they fall below minimum reserve requirements imposed by other federal laws, they can simply make up the difference by adding it on pro-rata to subsequent items sold to the federal government. The vast sums of federal tax money devoted to plugging the holes in the pension fund for the largest Pentagon contractor, Lockheed Martin, were discovered by Ken Pedeleose, an analyst at the Defense Contract Management Agency. He was concerned about staggering cost increases for the C-130J transport but a chart he made public showed the mind boggling per plane cost increases for a number of Lockheed Martin airplanes.

So, rather than dwelling on issues like productivity improvements and cutting more fat, auto companies and their unions might be better off focusing on the real enemies: Central Banks and government along with their crooked financial reports.

Today's Market

Overseas equities began the week on a positive note with Japan's Nikkei Index adding 41 points to 17,522. North American markets ended the day mixed with the DOW shedding 11.90 points to 12,469.10, the NASDAQ gaining 6.70 to 2,455.63 and the S & P adding 1.40 to close at 1,437.50. NYMEX crude oil futures added .65 to end the day at 62.93 per barrel.

Interest rates were 1 – 2 basis points lower across the curve with the benchmark 2-year note ending the day at 4.59%, the 5-year at 4.49% and the 10-year at 4.60%.

On foreign exchange markets the U.S. Dollar Index ended the day falling .20 to finish at 82.80.

The precious metals complex showed solid gains with COMEX gold futures adding 6.80 to 664.50 per ounce while COMEX silver futures gained .18 to finish at 13.41 per ounce. The XAU gained 1.48 to 139.26 while the HUI advanced 5.07 to 345.93.

On tap for tomorrow, at 10:00 a.m. March Consumer Confidence data is due – expected 108.5 vs. prior 112.5.

Wishing you all a pleasant evening and a happy as well as prosperous tomorrow!

 

By Rob Kirby
http://www.kirbyanalytics.com/

Rob Kirby is the editor of the Kirby Analytics Bi-weekly Online Newsletter, which provides proprietry Macroeconomic Research.

Many of Rob's published articles are archived at http://www.financialsense.com/fsu/editorials/kirby/archive.html , and edited by Mary Puplava of http://www.financialsense.com

Rob worked on an institutional trading desk for most of the 1980s and right up until 1996. He also worked for 11 years at Prebon Yamane, an international inter-dealer broker of foreign exchange and interest rate products. He spent an additional year at another money/bond broker called Freedom Bond Brokers [which has subsequently been bought out by Cantor Fitzgerald], then spent two years at Garban Inc., another inter dealer bond brokerage in Toronto - and left the industry in 1996.

Rob started writing in 1997, and was involved in a number of entrepreneurial pursuits from marketing Buffalo meat to a part time stint in the giftware business. In 2002, he went to work for Investor's Group, the largest Mutual Fund Company in Canada. He worked there up until September '04 when he resigned to write about the markets - and his book - from a "gold bug's" point of view.


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